Question

(Calculating free cash flows) You are considering new elliptical trainers and you feel you can sell 4,000 of these per year for 5 years after which time this project is expected to shut down when it is learned that being fit is unhealthy). The elliptical trainers would sell for $1,800 each and have a variable cost of $900 each. The annual fixed costs associated with production would be $1,100,000. In addition, there would be a $5,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 5 years. This project will also require a one-time initial investment of $1,500,000 in net working capital associated with inventory, and that working capital investment will be recovered when the project is shut down. Finally, assume that the firm's marginal tax rate is 34 percent a. What is the initial outlay associated with this project? b. What are the annual free cash flows associated with this project for years 1 through 4? c. What is the terminal cash flow in year 5 (that is what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the project)? d. What is the project's NPV given a required rate of return of 11 percent? a. What is the initial outlay associated with this project? (Round to the nearest dollar.) b. What are the annual free cash flows associated with this project for years 1 through 4 (note that the cash flows for years 1 through 4 are equal)? (Round to the nearest dollar.) c. What is the terminal cash flow in year 5 (that is what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the project)? s(Round to the nearest dollar) d. What is the project's NPV given a required rate of return of 11 percent? (Round to the nearest dollar) Enter your answer in each of the answer boxes

Answer 1

a. Initial Outlay = Equipment cost + Net working capital requirement

= 500000 + 1500000

= 2000000

b Free cash flows (Same for year 1 to Year 4)

Particulars	Amount
Sales	7200000	4000*1800
Variable cost	3600000	4000*900
Contribition margin	3600000
Fixed costs	1100000
Depreciation	100000	500000/5
Profit before taxes	2400000
Taxes	816000	240000*34%
Net Income	1584000
Add : Deprecaiton	100000
Free cash flow	1684000

c. Terminal cash flow in year 5 = free cash flow in year 5 + terminal cash flows

= 1684000 + 1500000

= 3184000

NPV :
NPV = PV of Cash Inflows - PV of Cash Outflows
If NPV > 0 , Project can be accepted
NPV = 0 , Indifference point. Project can be accepted/ Rejected.
NPV < 0 , Project will be rejected.

Year	CF	PVF@11%	Disc CF
0	$ -20,00,000	1	$ -20,00,000
1	$    16,84,000	0.9009	$ 15,17,117
2	$    16,84,000	0.8116	$ 13,66,772
3	$    16,84,000	0.7312	$ 12,31,326
4	$    16,84,000	0.6587	$ 11,09,303
5	$    31,84,000	0.5935	$ 18,89,549
NPV	$ 51,14,068

Pls do rate, if the answer is correct and comment, if any further assistance is required.